Corporate and Project Finance Modeling

Chapter 37Resolving Circular References in Acquisition ModelsComputing Interest Expense on the Average Balance of Debt

An issue that not too many people care about is developing an elegant way to compute the interest expense on the average of the opening and the closing debt balances in a financial model. But for a few people who spend much of their lives in front of their laptops working on financial models, this and other circular reference problems are more important than many other issues that you read about in the newspaper where politicians go around and around in a circular manner and things never seem to get resolved. The topic of interest expense on average balances and other circular reference problems in which one calculation is a function of the second, but the second depends on the first, can cause many difficulties in financial models. Complicated debt structuring issues in project finance and corporate finance models that result in circular logic and other tricky programming issues are addressed in this part of the book.

Some analysts suggest that from a philosophical standpoint, circularity should not occur in financial models. The argument is that this problem of one item depending on another and the other item depending on the first does not occur in real-life transactions and therefore it should not be part of a financial model. If circularity existed in structuring a transaction, the process would work something like what happens in the following story of ...